Sequestration – the last opportunity for Republicans to redeem themselves

Posted by Shyam Moondra

During 1995 and 1996, Congressional Republicans, under the leadership of Speaker Newt Gingrich, passed bills that would have severely cut spending in such areas as education, Medicare, environment, and public health (areas favored by Democrats) to tame the run away budget deficit caused primarily by tax cuts enacted by Republican President Ronald Reagan as part of his so-called “trickle-down” economics. Those partisan budget actions forced Democratic President Bill Clinton to veto the bills that led to government shutdowns for several weeks in the late 1995 and again in early 1996. The twin government shutdowns resulted in interruption of essential services, causing delays and hardship to the citizens. The public’s outrage led to Clinton’s victory in his re-election bid in 1996. During his second term, Clinton managed to increase taxes for the rich to reduce budget deficit in return for agreeing to reform the welfare programs and subsequently the economy took-off. The stock market set new records and the unemployment rate fell to 4.5%, which is considered as the lowest possible "full employment" rate. By the end of his second-term, Clinton not only balanced the budget but he left the office with a small budget surplus. Many historians consider the Clinton era as one of the most prosperous periods in the nation’s history. After the poor showing of Republicans in the mid-term elections of 1998, Gingrich was forced to resign as the Speaker of the House. Ultimately, Republicans lost the control of the House and Senate to Democrats.

One would think that Republicans learned their lesson and would not make the same mistake again. But, a decade later, Republicans’ extreme tactics on budget issues are backfiring on them, once again. In 2011, Republicans waged an ugly debate on extending the debt limit which resulted in the historic downgrade by rating agencies of the U.S. government securities from AAA to AA+. Then came the “fiscal cliff” (convergence of expiration of Bush tax-cuts and mandated spending cuts), which was avoided only when Republicans, at the last minute, blinked and agreed to tax rate increases for the rich (those making more than $500,000 a year) to seal a deal with Democratic President Barack Obama. The public’s disapproval of Republican tactics led to the re-election of Obama in 2012 and a net loss of seats for Republicans in the Senate and House. Now, Republicans are again engaged in extreme budget tactics via sequestration that are highly unlikely to produce any better results for them than last time.

Sequestration, agreed to by both Democrats and Republicans in 2012 as a way to avoid making hard compromises on tax and spending issues during the election season, involves across-the-board cuts in discretionary federal spending (entitlement programs such as Social Security, Medicare, and Medicaid are unaffected) amounting to $85 billion between March 1 and September 30 of this year (if these cuts are continued over a period of ten years, they would reduce the budget deficit by over $1 trillion). Both Republicans and Democrats have mixed feelings about these automatic cuts – Republicans are happy that sequestration would finally force the government to slim-down but they are also unhappy that these cuts would hit the Defense Department the severest, thereby negatively affecting national security, and that the entitlement programs are off-limit; Democrats are happy that sequestration would reduce the bloated budget for the Pentagon that they have been trying to cut down for years, but they are also unhappy that these automatic cuts would negatively affect many of their favorite programs such as Head Start. At the time when sequestration was agreed to, it was thought that both sides would find parts of these automatic cuts so drastic that they would never dare to carry out these cuts and perhaps be more amenable to compromises.

Sequestration may not produce hardship to the citizens immediately, but over the coming months as these cuts start biting, the people would begin to feel the pain (reduced federal services, canceled contracts, military base closings, and job furloughs and layoffs). The government has estimated that as many as 700,000 jobs would be lost and these cuts would reduce the GDP growth by at least 0.5%. When that happens, as the recent polls show, Republicans would face the wreath of public anger over their intransigence. With the 2014 mid-term election season beginning soon, it’s smart politics for Republicans to back off from their uncompromising positions. Unless Republicans soften their rigid ideology of “no new taxes” and they embrace a balanced approach to spending cuts and new tax revenues, as Obama and Congressional Democrats are advocating, they may end up repeating history and losing the control of the House in 2014. Then Obama and Congressional Democrats, with a firm control of the White House, Senate, and House, would be free to aggressively pursue their agenda on fiscal matters in the last two years of Obama’s second term.

The deficit is too big (caused by Bush's two costly wars, unnecessary tax cuts to the rich, and bank bailouts that became necessary because of lax regulations under Bush) to be remedied by spending cuts alone; new tax revenues would have to be part of the solution. When special deductions and exclusions enable rich people like Mitt Romney and billionaire Warren Buffett to pay only 13-20% in taxes, it raises the question of fairness. When tax loopholes, added to the tax code over the years at the behest of lobbyists of special interest groups, enable rich companies like GE, Google, Apple and Goldman Sachs to pay only 0 -10% in taxes, that’s a problem. Clearly, rich individuals and corporations are not paying their fair share of taxes. Closing tax loopholes and eliminating tax giveaways is not the same thing as increasing taxes. This is more about cutting tax expenditures that we can’t afford.

If Republicans work cooperatively with Obama and Congressional Democrats in resolving the sequestration, they might improve their chances of winning the 2014 Congressional elections as well as the next presidential election in 2016. The sequestration, which no one likes, is the last opportunity for Republicans to repair their shattered image caused by their serial manufactured fiscal crises. Obama has already offered to put on the table entitlement reforms (that Republicans want) in return for higher tax revenues via tax reforms (that Democrats want). Several bipartisan groups, including the commission on deficit and debt led by Erskine B. Bowles and Alan K. Simpson, have called for one dollar of tax increase for every $2-3 of spending cuts. If Republicans and Democrats work together over the next few weeks and come up with a grand plan which would replace sequestration with a more balanced mix of spending cuts in discretionary as well as entitlement programs and fair tax reforms with a net increase in tax revenues, the country would be set for a sustained recovery for the long-term with millions of new jobs created. This is what an overwhelming majority of people want and this is what will restore the good image of the Grand Old Party.

If Republicans fail to seize this last opportunity that sequestration has presented to them for redeeming themselves, the consolation prize for the people would be that if the “fiscal cliff” and sequestration agreements on spending cuts and tax increases are carried out in full, the budget deficit would be reduced by about $4 trillion over ten years. This level of austerity would certainly cause some hardship in the near-term, but it would also be a big leap in improving the long-term fiscal health of the country. Of course, a grand plan, which includes entitlement reforms and tax revenues, would put us on a path of stronger recovery sooner and everybody would win, including the Republicans.

“Fiscal Cliff” will push the Republican Party over the cliff

Posted by Shyam Moondra

Since Ben Bernanke, the FED Chairman, first coined the term “fiscal cliff” last February, it has taken its own life and is now being used universally by the media and investors around the world. The term “fiscal cliff” refers to the convergence of the expiration of a variety of tax cuts (e.g., the so-called Bush income tax cuts, temporary payroll tax cuts, estate tax cuts, and investment tax cuts) and across-the-board spending cuts (equally divided between defense and non-defense discretionary expenditures) on January 1, 2013. At that time, additional health care taxes related to the Patient Protection and Affordable Care Act of 2010 would also go into effect. These automatic tax increases and spending cuts (known as “sequestrations” in the Budget Control Act of 2011), if carried out in full, could reduce budget deficit/debt by as much as $7 trillion over ten years. Bernanke has warned that these precipitous tax increases and spending cuts at a time when economy is still recovering at a tepid pace could push us into another nasty recession. The investors are very skittish about the impending catastrophe and they are reacting to every word uttered by Republicans or Democrats on the status of negotiations to save the country from falling off the “fiscal cliff.” Most corporations have put their plans for capital investment and hiring on hold until there is more clarity on if there is political will on the part of Republicans and Democrats to compromise and come up with a more modest deficit reduction plan of the order of $1.2 trillion over ten years (as required by the Budget Control Act to avoid automatic tax increases and spending cuts) before the end of the year (actually, within the next three weeks before the Congress adjourns for the Christmas holidays).

President Barack Obama has proposed a budget plan which would increase taxes by $1.6 trillion (the Bush tax-cuts for the middle class would be made permanent while tax-cuts for the rich would be eliminated along with investment and estate tax cuts) and reduce spending by $600 billion over ten years for Medicare, Medicaid, farm subsidies, and other programs ( these spending cuts are over and above $1 trillion of spending cuts that the president and Congress committed to last year for the coming decade and a reduction of $800 billion in projected war spending, reflecting the winding down of the U.S. combat operations in Afghanistan and Iraq). House Speaker, John Boehner, has called Obama’s plan as not “serious.” Republicans don’t want to increase tax rates for the rich (although they are open to reducing deductions to have a net increase in tax revenues by a smaller amount than what Obama wants); they want to rely primarily on deep spending cuts in the entitlement programs to balance the budget, which is vehemently opposed by Democrats. So, lines have been drawn in sand by both sides; they are miles apart and very little time is left to bridge the gap before the country goes over the “fiscal cliff” in less than a month.

Implications of “fiscal cliff”

Below are some observations on where things stand in the aftermath of the November elections and what “fiscal cliff” means to both Democrats and Republicans:

• Obama fought the election based on his vision of reducing budget deficit/debt by increasing tax rates for the rich (those making at least $250,000 a year) while preserving the lower tax rates for the middle-class. Not only Obama got re-elected, but his policy platform also brought net gains for Democrats in the Senate and House. Democrats view these election results as a mandate on their tax and spending policies. The post-election polls also show that voters overwhelmingly support Obama’s vision of balancing the budget by increasing taxes and closing loopholes for the rich. Republicans are clearly in a much weaker position now than they were before the election.

• Republicans believe that higher taxes on the rich will negatively affect economic growth and hamper job creation. The historical data, however, doesn’t support these assertions. Trickle-down economics was enacted by Republican Presidents Ronald Reagan and George W. Bush, and both times we ended up with recessions and high unemployment rates. On the other hand, when Democratic President Bill Clinton raised the income tax rates for the rich to the highest levels in modern history, he not only achieved a budget surplus but his policies brought sustained prosperity for people from all walks of life for a decade (with unemployment rate falling down to as low as 4.5%, which economists consider as “full employment” level). Therefore, the pro-rich agenda of the Republican Party doesn’t resonant with the electorate.

• Obama wants the top individual tax rate to go up from the present 35% to 39.6%. However, the fact of the matter is that very few rich individuals pay the highest rate because of all kinds of income exclusions and deductions that have been added to the tax code over the years, mostly by Republicans who favor the rich (rich individuals reciprocate by showering Republican candidates with lavish amounts of campaign contributions). The problem is illustrated by Mitt Romney, who earned tens of millions of dollars a year but paid as little as 13% in federal taxes during the last ten years, thanks to his aggressive use of income exclusions and deductions. Increasing the top marginal rate by itself is not going to do much good unless, at the same time, the tax code is simplified and most income exclusions and deductions are weeded out.

• Obama won the election because his vision enabled him to put together a winning coalition consisting of women, Blacks, Hispanics, young voters, veterans, and middle-class white voters. Due to demographic changes, the continuing growth in the Obama coalition will only make it harder for the Republicans to win elections in the future, if they continue to stick to their philosophy of unproven trickle-down economics. That means Republicans are better off to negotiate the best deal they can get now.

• If Republicans choose to let the country fall off the “fiscal cliff” (let all tax cuts expire and automatic spending cuts go in to effect), most economists believe that economic growth will decline, pushing us back into recession with unemployment rate rising again. The automatic tax increases would, however, technically not count as Republicans’ violating their pledge to not increase taxes (because they wouldn’t really vote for tax increases). And then in 2013, when the next Congress convenes, Republicans could vote for a tax cut for the middle-class, which doesn’t violate their tax pledge either. However, higher unemployment rate, crashing financial markets, and possible downgrade of the rating of the U.S. government securities by rating agencies could lead to a backlash against Republicans in the Congressional elections of 2014. The voters could give Democrats a filibuster-proof majority in the Senate and the control of the House. With Democrats in charge of the presidency, Senate, and House, Obama could then swiftly move to implement his agenda in the last two years of his second term. An increasing number of Congressional Republicans are beginning to realize that their firm posture on extending Bush tax-cuts for the rich may not only push the country off the “fiscal cliff,” but it may in fact push the Republican Party off the cliff. In a post-election survey concerning the “fiscal cliff” conducted by Pew Research Center, about half of respondents believed Congress will fail to reach an agreement to reduce the country's budget deficit compared to only 38% who said a deal will be met. If the two sides fail to find common ground on reducing the deficit, 53% said congressional Republicans will be to blame while 29% said the responsibility will fall on Obama.

• In a strange way, if there is no compromise between the Democrats and Republicans over the “fiscal cliff” before the end of the year, some investors might think of this as a positive development. While “fiscal cliff” would cause reduced consumer spending and economic slowdown in the near-term, the budget deficit and debt situation would be greatly improved in the long-term. If the automatic tax increases and spending cuts of January 1, 2013 are carried out in full, they will reduce deficit (or avoid debt) by $7 trillion over ten years. This will go a long way towards putting our national financial house in order, which will be very positive for the long-term economic growth. Therefore, in the short-term, the stock market may decline, but the chances are that it will bounce back rather quickly. In 2013, Republicans and Democrats may hammer out a $4.5 trillion plan, as originally envisioned by Obama and Boehner last year, which incorporates higher taxes for the rich and lower taxes for the middle-class and meaningful reforms of the entitlement programs. Such a breakthrough plan could push the financial markets to record high levels.

Possible Comprehensive Deficit/Debt Reduction Plan

The following could form a basis on which to work out a comprehensive plan to reduce deficit and debt:

1. Taxes:

o Make Bush tax cuts for the middle-class (family income less than $250,000 per year) and small businesses permanent.

o For high-income earners, let the Bush tax-cuts expire and also limit income exclusions and deductions to $35,000 (as suggested by Romney). As an alternative, impose AMT of say 25% of gross income, so all rich people will pay a minimum of 25% in taxes. When Romney pays only 13% or Warren Buffett pays only 20% in federal taxes, it's just morally wrong.

o Capital Gains/Dividend Taxes: These Bush tax breaks encourage saving and investment, and they also benefit the middle-class. Therefore, they must be made permanent.

o Estate Taxes: These taxes should be increased, but not by as much as what liberals want. Republicans and Democrats should find a compromise.

o Corporate tax loopholes must be closed. It's wrong when GE pays 0% and Google and Goldman Sachs pay only 10% in federal taxes. Our corporate tax rate may be high, but the reality is that most companies don't pay anywhere near the top rate. We need a plan that would make corporations pay a lot more in taxes than they are paying now - we need to close down all the loopholes that companies use to reduce their tax liabilities.

2. Health Care: Revisit the Obamacare and make some adjustments to provide relief to small businesses.

3. Entitlements:

o Medicaid: Medicaid is the worst program ever created by the federal government. There is so much potential for fraud that this program, in its current form, can't be sustained by the taxpayers. Many poor people are using Medicaid fraudulently to put some cash in their pockets. They visit doctors and undergo unnecessary treatments and, in return, some doctors and other service providers share part of their fee paid by Medicaid with the patients. Medicaid was intended to provide health care for the poor people, but some of them are using it as a cash-cow. No amount of enforcement will ever catch this kind of fraud. As the health care costs continue to go up and health care becomes unaffordable, more and more people would end up in Medicaid. Therefore, there is simply no way this program can be viable in its current form for the long-term. The federal government should give a fixed grant to the States (increased over time to keep up with the general inflation rate) and let individual States administer health care for the poor.

o Medicare: There should be no change in retirement age. We could increase the deductible and the Medicare tax rate and make benefits a function of income (rich people get minimum Medicare benefits or no benefits at all). There should be increased funding for fraud prevention. There is no support for the Republican idea to convert Medicare into a voucher program.

o Social Security: There should be no change in the age requirement or COLA calculations. We could increase the income limit which is subject to social security tax and we could make benefits a function of income (rich people get reduced benefits or no benefits at all). There is zero support for Republican idea to privatize Social Security.

4. Provide increased funding for Education. The U.S. students are sliding down fast in test scores compared to other countries which will negatively affect our competitiveness in the future.

5. Our infrastructures are crumbling (bridges, highways, roads) - during the recent Hurricane Sandy, we saw how antiquated our power grid and telephone infrastructure are. The government and corporations need to step up and modernize the infrastructure. We could impose a special tax on gasoline to pay for increased investment in our infrastructure.

Time of reckoning has come for Republicans – either do what the electorate wants or become irrelevant

Posted by Shyam Moondra

Republicans campaigned based on trickle-down economics and lost. Not only they failed to win the presidency, they also lost seats in the Senate and House of Representatives. Republicans pursued a policy agenda that defied voter preferences (e.g., voters overwhelmingly want rich people to pay higher taxes) and they paid a price. Now the “fiscal cliff” is looming on the horizon, which has the potential to crash the financial markets and decimate people’s 401(K) and IRA savings a second time in less than five years. If Republicans don’t change their strategy, they would lose big time in the 2014 Congressional elections. In 2014, Democrats will most likely control both the Senate and House, and President Barack Obama will be free to execute his agenda on taxes, deficit/debt, education, immigration, energy, health care, and entitlement programs in the final two years of his second-term. In a nutshell, Republican Party will become irrelevant. That means, Republicans are better off to negotiate the best deal they can get now. Obama won, so he deserves to have some leeway in executing his policies; that's what the voters said loudly in the election.

Republicans’ trickle-down economics favoring the rich is inconsistent with the evolving mix of the electorate in which non-whites, most of whom are low-income and middle-class families, are growing the fastest and have a big say in the final outcomes of democratic elections. Clearly, the Republicans need to be more inclusive, if they want to win elections; and that means, they need to modify their agenda and move away from the unproven assertions that what’s good for the rich is good for the country or that rich people are the job creators. The Republicans need to start becoming part of solutions rather than continue to boil the pot based on extreme ideologies that are not supported by the electorate. House Speaker John Boehner must work with Obama and Congressional Democrats to form a winning coalition of moderate Republicans and Democrats - that's the only viable way forward.

Effective January 1, 2013, all Bush tax cuts will expire, so will temporary payroll tax cuts that were advocated by Obama as a stimulus to the sagging economy, and there will be significant across-the-board spending cuts. These tax increases and spending cuts at a time when the economy is still trying to recover from the 2008 recession would decimate the economy and push it back into recession with unemployment rising to double-digits, again. This, so-called “fiscal cliff,” will crash the financial markets, wiping out the wealth created in the last few years. Also, if the country is pushed over the cliff, the debt rating of the U.S. government securities will be downgraded for the second time in a short period of two years, which will put the upward pressure on interest rates. Higher interest rates will increase the interest expense for the government, thereby widening the budget deficit even more. The costs of a “fiscal cliff” are too high to contemplate and both Republicans and Democrats owe it to the people to reach a compromise and avoid the catastrophe. Given that Republicans lost the election, they have the primary responsibility for reaching out to the Democrats and making the necessary compromises (especially on increasing revenues by making rich people pay higher taxes) well before the end of the year. The Democrats also bear the responsibility for reaching out to the Republicans in carving out compromises on reforming the entitlement programs.

The continuation of the present gridlock in Washington, DC would be very damaging to the people and to the national security. Obama and Congressional leaders need to resurrect Obama-Boehner’s grand plan of reducing the deficit by $4.5 trillion over ten years; they could use that as a starting point and make the necessary modifications to reflect today's political reality in the aftermath of the 2012 elections and get it passed by the Congress as soon as possible, preferably before the end of the year.